Key Elements of an Exit Strategy "Planned Exits"
This series will discuss the common types of planned business exits. Like most answers in the real world, the right plan and strategy depends on the specific goals and objectives of the individual Business Owner. Some have family members to pass the business on to, others will depend on the exit to fund retirement, some may have a management team who has been groomed to take over the business, others may have to liquidate the business due to changing market conditions. Exit and business succession strategy and planning come in all shapes and sizes. The main key is to be in the small minority of business owners who actually have a plan! Price Waterhouse Cooper’s estimates that nearly 88% of business owners do not have a succession plan in place. This series will explore common exit options and some of the nuances of each.
These are the most common exit strategies we see and will be discussed:
Transfer to Family
Management Buyout
Employee Stock Option Plan (ESOP)
Sale to Strategic Buyer
Sale to Financial Buyer
Develop a Lifestyle Business
Liquidate
Merge
Bankruptcy
Selling the business for the most amount possible is not always the sole focus of every business owner – some simply want to build a legacy to pass on to family (or so they think!). Remember it’s a two-way street and your plans will not always resonate with your successors. PWC’s Family Business Survey reports that 66% of family businesses fail to transfer to 2nd generations and only 12% remain multigenerational.
Ensure the family member is passionate, competent and aligned with the existing vision. Despite their interest to take over the business, they may not be qualified, competent or responsible enough to run the business. Take steps to educate them on every facet of the company and train them to run the business. Make sure they prove themselves capable of running the business and have earned the respect of employees. Various business structures will affect risk, assets, management, ownership, and taxes, so work with competent advisors to determine the appropriate legal entity and if tax strategies such as setting up a family limited partnership should be done.
Transferring business ownership to a family member brings a unique set of challenges and family dynamics. There are advisors who specialize in this area and can help you navigate these waters, so seek them out!
A Management Buyout can be a good option for owners looking to exit their business with a strong management team in place. A qualified management team understands the business. its operations & can usually receive favorable funding from lenders and investors. Ensure that you are transparent with managers early-on in the process so they will buy in & help with planning. Also, ensure that they are properly trained & are competent leaders. Many managers have trouble adjusting to the nuances of business ownership & leadership. A good manager doesn't always make a good business owner!
Get buy-in from employees, suppliers, bankers, other stakeholders...etc, early on as these parties will be critical to the on-going success of the business. Work with advisors to develop the financing structure. The primary methods of financing are with stock, debt, cash or a combination. One option is to create an Employee Stock Option Program early-on that can allow the gradual transfer of ownership at a reduced cost.
A management buyout has many benefits & can take away some of the doubt & uncertainty that comes from the selling a business on the open market. There are a lot of nuances, tax & legal issues that are unique to a management buyout, so work with competent advisors.
A strategic buyer is a competitor or industry peer that wants to grow through acquisition. Strategic acquisitions provide many advantages to the seller and typically yield the most attractive financial terms. Many buyers are willing to pay a premium for the following “strategic” reasons:
Growth through acquisition - saves on the time, effort, and R&D costs that are associated with organic growth.
Ability to capture synergies - strategic buyers have superior infrastructure and distribution capabilities that improve revenues, eliminate overlapping costs, and improve efficiencies.
Add existing or ancillary/complimentary products and services to current offerings.
Expand geographical footprint into new markets.
Reduce competition and capture market share.
Deep pockets – Strategic buyers often have deployable capital and can pay cash. In some circumstances they may structure an earn-out contingent on the performance of the acquisition. This provides both upside and downside risk to the seller and sellers should work with an M&A Advisor and lawyer to ensure favorable terms.
Just remember that selling to a Strategic buyer will most often yield the most attractive financial terms!
A merger-of-equals occurs when two companies of similar size combine to form a single larger ent i ty. In many cases the two ent i t ies will keep all or most of the existing owners and employees and can form a strategic alliance or joint venture under a new name/ent i ty. In other scenarios, the more predominant company may take majority ownership and full control of the “merger sub” and create a subsidiary that is wholly owned by the parent. The advantages are essentially the same as selling to a strategic, in that the business (es ) grows through acquisition, develops cross-selling opportunities, and creates synergies. The most common transaction structures are stock and as set purchases and can provide favorable terms when it comes to the taxable gains on the sale of the business.
Financial buyers focus on the cash flows of a business and are primarily motivated by financial returns from the cash flow of the acquired business. They are typically funded by pooling capital from high net-worth individuals or institutional investors and then using debt to provide a higher “leveraged” return to their investors. Financial buyers consist of Private Equity Firms Venture Capital Family Offices High Net Worth Individual Entrepreneurs who have exited a business. Some financial buyers acquire businesses as long-term investments, but most try to grow the business quickly and resell it for a profit in 5 – 10 years.
Liquidation is not typically thought of as the most desirable exit strategy but sometimes this can actually be a very viable and profitable option. The need for a liquidation Exit Strategy occurs when the cash flow from the business reaches a level where the business is worth more by selling off the assets than selling the business. This typically occurs in a very asset-heavy business that owns valuable real estate, equipment, or other assets that can easily be sold. We worked with the seller of a nursery in Bellaire, Texas, and an appliance showroom in the Woodlands, Texas. The value of their land increased significantly over the years. When we started looking at Exit Strategies and Valuation for their businesses, the highest value for both of them was to liquidate the business and sell the real estate to developers and the assets to competitors. Both the sellers walked away with a substantial amount of money by liquidating the assets.
Businesses that run with little owner involvement (Lifestyle Businesses) are typically more valuable and marketable so even if this is not your ultimate Exit Strategy these steps can be beneficial: Develop Strong Management– competent, reliable & trustworthy manager(s) that takes care of the day-to-day operations are integral. Trust is crucial, not just for success but also for peace of mind. You can instill a sense of ownership by awarding target-based bonus compensation Reliable Processes and Controls– Set up good procedures and a system of checks and balances that allow you to monitor operations and financial performance while away from the business. Good processes and controls will streamline operations, reduce intervention, and likely improve margins and profitability. Test in Short Periods– Fellow Rice alum Gustavo Kohmel tested his ability to be away from his business by starting with vacations of one to two weeks and eventually taking an extended RV trip throughout the US. During his trip, the business had record months and upon arriving back in Houston the employees told him to stay away! Business owners who build a business that can run without them in essence sell the business to themselves as an Exit Strategy.
Well, we saved the bad news for last! Bankruptcy: Not all businesses have a successful exit as unforeseen challenges can force a business into considering bankruptcy as the only exit strategy. Bankruptcy is about cutting losses & the key to cutting losses is to cut them as soon as possible. However, pride and the passion to succeed often stand in the way of making the tough decision to consider bankruptcy & can make a bad situation worse. When the business starts to consistently lose money & there is no change in sight, it may be time to start considering bankruptcy as the exit strategy. Remember that just because the business files for bankruptcy doesn’t mean the owner has to file as an individual. The owner is separate from the business especially if no personal guarantees have been signed for the obligations of the business. There are two main types of bankruptcy, if the situation is temporary, Chapter 11 allows the business to continue operating & negotiate the settlement/restructuring of its existing obligations, which it will have to repay. Chapter 7 bankruptcy is when the business is forced to close its doors. Chapter 7 involves the liquidation of the business assets. If considering bankruptcy as an option, there are experts who specialize in this area.
Planning your business exit strategy ensures a smooth transition. From family transfers to management buyouts, having a clear plan is essential. Don't wait—join the prepared minority.
Contact us at info@exitadvisors.com for expert assistance with your exit strategy.
